Diverging central banks

In early June, Canadian benchmark rates hit new lows for the year, as the possibility of new tariffs on Mexican goods scared investors into buying safety, which drove 5-year rates down below 1.30%. Over the following weeks, however, these threats turned out to be moot, and the Bank of Canada said that rates were appropriate for the times. This helped drive the yield curve back up, with 5-year rates nearly hitting 1.60% in early July.

Fast forward to this week, and focus is now turned on different threats, this time from the ongoing US and China trade dispute, and in particular, the drop in the Chinese Yuan. This had a serious effect on equity markets, which saw their worst trading day of the year on August 5th.  Rates also turned way lower thanks to the increasing likelihood of a trade war-driven recession which drove a flight to quality; Treasuries, Bunds and gold have been major beneficiaries.  What does this mean for the future path of rates? With the Fed Funds rate now lower by 0.25%, the US market is pricing another 4 rate cuts for the next 12 months, while in Canada, 2-3 rate cuts are now priced in.  In our view,  the BoC could distance itself from the Fed and stand firm for the next 12 months; we therefore are of the belief that rates have decreased too soon and too fast. If our beliefs are correct, expect rates to move modestly upwards over the foreseeable future.